Monday , 19 August 2019


Gold vs Oil: Which Is Currently Over-Priced? Which Has Greater Upside Potential?

Do you know which commodities are over-priced and which are under-priced? Here’s a look at the 2 commodities that act as beacons for hard asset investors – gold and oil – and a current gold/oil ratio that begs the question “Is crude oil getting pricey or is gold too cheap”.

Written by Lorimer Wilson, editor of munKNEE.com

There’s a relationship between gold and oil that’s worth understanding because each, being valued in U.S. dollars, serves as a measure of inflation and, since both commodities have a common denominator, it’s easy to price one against the other.

The chart below shows the number of barrels of $WTIC oil one (1) troy ounce of gold ($GOLD) would buy for the 18.5 years between January 1st, 2001 and June 21st, 2019:

yield curve inversions

Currently (June 21st) 1 troy ounce of gold (@$1400.10/ozt) will get you 24.38 barrels of West Texas Intermediate Crude oil (@$57.43/bbl). As history illustrates in the 18.5-year chart above, high or low extremes in the Gold:WTIC Ratio (GOR) are always quickly followed by a mean reversion – either oil plunges or gold soars, or both – to bring the GOR back in line, and that has been a 47-year monthly average of 15.4.

As a rule of thumb:

  • when the ratio is below 9, oil is relatively expensive (and gold is relatively inexpensive) and
  • when the ratio is above 20, oil is relatively inexpensive (and gold is relatively expensive). 

My recent Dow:Gold ratio analysis (see here), however, concludes that, due to a long, deep inflationary recession, the Dow:Gold ratio will eventually arrive at a 1:1 with: 

  • Gold at $5,000 (& the Dow at 5,000),
  • Gold at $10,000 (& the Dow at 10,000) or perhaps even
  • Gold as high as $12,500 (& the Dow at 12,500).

Time will tell.

 

 

 

Given the above, the only way I can see the Gold:WTIC reverting to the historical 47-year monthly average of 15.4 is for:

  • WTIC oil to go UP to $91/bbl were Gold to remain unchanged in price at $1,400/ozt.
  • or WTIC oil to decline drastically – perhaps to as low as $25/bbl due to a long, deep deflationary recession – but, gold, in turn, would need to drop to $385/ozt to realize a Gold/WTIC ratio of 15.4.
  • Conversely, gold would have to go DOWN to $884/ozt were WTIC oil to remain unchanged at $57.43/bbl and incidentally, that is not that outlandish if you adhere to Harry Dent’s contention (read here and here) that gold is heading for $650-$750 initially, and that it will ultimately revert to its bubble origin of between $400 & $450/ozt.

Conclusion

Based on historical gold:WTIC ratios the current ratio suggests that further improvement in the price of crude oil is just around the corner and that long positions in crude oil will become quite profitable in the near future.

(It should be noted here, however, that others have a different take on the situation. According to an article on Seeking Alpha “Crude oil is fundamentally bearish. Supply is surpassing demand and [crude oil] stocks are rising at a time when they should be falling. This is why price is falling in WTI futures and, therefore, why price is falling in USO. As long as this oversupply situation remains, we will see prices in WTI futures likely continue to fall. [Editor’s note: But will they ever eventually decline into the lower $20s?]. For that reason, I suggest investors maintain short positions or exit any remaining longs.”)

Addendum (source)

[A significant rise in the gold-to-oil ratio tends to precede critical junctures in equity markets and the global economy. We experienced a similar breakout:

  • in the global financial crisis,
  • in the European debt crisis,
  • at the first glimpse of the China bust in 2015,
  • and at the early stages of the market selloff in November of 2018.

After surging ahead of the G-20 meeting in Argentina we are now seeing a similar move ahead of the same meeting but this time taking place in Japan.]

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One comment

  1. The following are insightful comments from a loyal subscriber:

    Lorimer,

    Good effort! Do more. Whatever you’ve said, you stated your facts and assumptions and drew your conclusions. Solid work!

    A couple of personal and not substantiated observations by me.

    1. First is that Harry Dent seems totally intent on gaining attention and denigrating precious metals. He always has and continues to do so. Talking $600 +/- Gold is attention grabbing, but the cost of production is more or less $1,200. Markets and investors know facts like this so talking like that as if it is logical is in fact bizarre!

    2. Plus the quantity of available gold is so small relative to…other markets that should there be any genuine interest and move by governments, big money management funds or any other money, prices could be dramatically higher, even if the purpose is only to have a small degree of exposure, protection, diversification and insurance. Those governments which have been buying gold like Russia and China, et al want to keep the price down until they’ve got enough and have cornered the market.

    3. However, what makes me interested in gold in the future is a crypto currency backed by gold. That gets everyone around the spying eyes of governments and also allows governments to extricate themselves from the US dollar and the US increasing inclination to impose currency constraints on nations whose policies they don’t like, including the SWIFT dollar transfer system.

    These events are gradual, something similar the time between WWI and Bretton Woods in late WWII to move the British Pound to the USD as the world’s reserve currency. All was gradual but ultimately it became reality.

    Current events are effecting the same movement away from the USD through a combination of low profile actions by governments like bilateral trade agreements whereby the other’s currency is accepted. Also, the Chinese have set up a gold backed Shanghai based oil payments system using the Yuan. In addition they have been working to parallel a variety of agencies involving a host of nations do things that existing financial agencies do. One day we will realize that the USD no longer prevails or dominates.